Love and taxes, Part II: Tax and estate planning for two spouses

I previously wrote about the importance of correctly reporting marital status on personal tax returns. The Canada Revenue Agency (CRA) is keenly interested in marital status, as certain benefits (including GST/HST credits, Canada child benefit, child-care deductions and eligible dependant claims) are calculated based on this status. However, marital status extends beyond checking a box on a tax return; it can play a role in deeper tax and estate planning scenarios. Consider the following hypothetical client scenario:

Kristy separated from her spouse, Ken, eight years ago. They were married for 10 years prior to their separation and are not yet divorced. The separation was amicable — in fact, the two remain good friends and co-parent their 15-year-old daughter, Nicole.

For the past five years, Kristy has been living in a common-law relationship with her partner, Fred.

In thinking about estate planning, Kristy would like to understand her options for the transfer of her assets upon her death. She’s heard about tax-deferred transfers (i.e., rollovers) to spouses but would like to understand how this might apply to her, given her separated status and common-law relationship. Specifically, Kristy would like to know:

• Are spousal rollovers available for both registered and non-registered assets?
• Who is her spouse for purposes of these rules — her separated spouse, Ken, or her common-law partner, Fred?

Kristy’s assets, all solely owned, are listed in the table below.

Table: Kristy’s assets to be transferred at death

¹Canadian property  ²Not relevant to this discussion

Canadian tax rules state that when non-registered capital property (e.g., real property, stocks, bonds, mutual funds, etc.) is transferred to a Canadian-resident spouse or common-law partner at death (or to a Canadian trust for the benefit of a spouse or common-law partner), a tax-deferred rollover is possible, deferring taxes to the future sale of the property (or death of the spouse or partner, whichever occurs first).¹

For registered assets, a tax-deferred rollover is available for RRSPs and RRIFs when a spouse, common-law partner or financially dependent minor child or grandchild (or child or grandchild with a disability) is entitled to the RRSP or RRIF assets and they transfer the assets to an eligible registered plan for their benefit. For TFSAs, the value of the account at the time of the holder’s death is tax-free regardless of who the beneficiary is.

This leads to the next question: who is a spouse or common-law partner for purposes of these rules?

For tax purposes, the term “spouse” refers to a person to whom you are legally married. A “common-law partner” refers to a person to whom you are not married but are living with in a conjugal relationship that has lasted for a period of at least one year (or that person is a parent of your child).

As confirmed by CRA technical interpretation 2014-0523091C6, it is possible to have both a spouse and common-law partner at the same time. For example, when an individual is legally separated but not divorced and has a common-law partner at death, a tax-deferred rollover of non-registered capital properties to both the separated spouse and common-law partner is possible. Similarly, for RRSPs and RRIFs, technical interpretation 2006-0189141E5 confirms that tax-deferred transfers to RRSPs, RRIFs and annuities for both separated and common-law partners are permitted where rollover rules are met.

Applying these concepts to Kristy, assuming she predeceases both Ken and Fred and current rules apply at the time of her death, she would be considered to have two spouses — a separated spouse and a common-law partner — for purposes of the rollover rules.

To reduce taxes for her year of death, Kristy’s principal residence can be transferred to Fred directly or, as per her specific testamentary wishes for the property, to a spousal trust for his benefit, without taxation. Thereafter, on transfer of the property to Nicole on Fred’s death, tax would likely be avoided through the principal residence exemption.

Kristy’s non-registered mutual fund account can also be transferred to Fred on a tax-deferred basis along with her bank account. Given that these assets are non-registered and solely owned, estate administration fees (e.g., probate) might apply where applicable.

Similarly, the tax rules allow for Kristy’s vacation property to be transferred to Ken either directly or to a spousal trust for his benefit without taxation. Tax would be deferred until a future sale of the property or on Ken’s death upon transfer of the property to Nicole.

Kristy is undecided about who will receive her RRSP upon her death. She can take comfort in knowing that both Ken and Fred would be eligible to receive the proceeds on a tax-deferred basis provided they transfer the assets to their own RRSP, RRIF, pooled registered pension plan (PRPP) or annuity. Alternatively, she can leave the RRSP to her minor child, Nicole, although the rollover would not be available past age 18 unless Nicole has a disability.

When thinking about these rules, keep the following in mind:

• With some exceptions (for example, transfers while living), divorced spouses are generally not treated the same as separated spouses for tax purposes. Post-death rollovers to divorced spouses are generally not permitted.
• Tax-deferred transfers might not always make the most sense, especially when the deceased can make use of unused capital losses or low tax brackets for the year of death. Taxpayers can normally trigger taxes for the year of death where it makes sense to do so.

Canadian tax rules offer some flexibility when it comes to managing assets and intimate relationships. While the “two spouse” concept might spark debate in social circles, it is a confirmed possibility from a Canadian tax perspective.

Wilmot George, CFP, TEP, CLU, CHS, is vice-president, Tax, Retirement and Estate Planning with CI Global Asset Management. Wilmot can be contacted at wgeorge@ci.com.

1 To achieve the rollover, the property must vest in the spouse, common-law partner or trust within 36 months of the transferor’s death (or longer subject to written application to tax authorities).

Wilmot George

Tax & Estate

Wilmot George, CFP, TEP, CLU, CHS, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. Wilmot can be contacted at wgeorge@ci.com.